With all the talk of inflation and interest rates recently, it seems everyone is forgetting China.
Obviously, the direction of interest rates are hugely important for the stock market. But the direction of China is hugely important for our economy and one of its largest sectors: iron ore.
A month ago, Evergrande and China’s property sector were in the news 24/7. Evergrande is was one of China’s largest property developers. It was a victim of regulatory efforts to rid the sector of speculation and excess leverage.
The permabears hoped it would be a ‘Lehman moment’, but as I said at the time, that was just wishful thinking.
No, China’s property downturn is manufactured. The authorities want to redirect capital and growth from property to elsewhere. If they let the bubble continue, it risks undermining social stability, which would be a mortal threat to the ruling communist party.
But they don’t want the adjustment to be destabilising. It will take time. Just because it’s now off the radar doesn’t mean the adjustment isn’t taking place.
With this introduction, a few articles caught my eye this week…
Firstly, from the Financial Times:
‘Chinese regulators have eased pressure on property developers by loosening credit controls and allowing more bond issuance in recent weeks in an effort to prevent the sector from collapsing. But analysts and government advisers say the measures do not represent a retreat from President Xi Jinping’s crackdown on the sector…
‘A Beijing-based policy adviser said: “All of our previous attempts to regulate the real estate market have failed because we exited halfway through overhauls. This time the central government is determined to stick to the plan.”’
And this from South China Morning Post:
‘“Unstable and uncertain factors, at home and overseas, are increasing and China’s economy is facing new downward pressure,” Li Keqiang said on Monday in Shanghai when meeting with officials from 10 provincial governments, according to the state news agency Xinhua.
‘The meeting included the heads of economic powerhouses like Shanghai, Guangdong, Jiangsu and Zhejiang, but also governors from less economically-vibrant regions, such as Guizhou and Jilin.
‘Li urged local governments to take more action to support small businesses and make them a major economic priority, such as offering more tax cuts and helping them with payments in arrears.’
For the past decade, local government officials have grown fat off the teat of land sales. They sell land at ever-inflating prices to developers. Developers then sell apartments at ever-inflating prices to the public.
Many of these apartments remain unoccupied. The thinking is that an unlived-in property has better resale potential.
As a result, Xi Jinping has stated many times that property ‘is for living in, not for speculation’.
The fact that Premier Li Keqiang is meeting with local government heads urging them to support small businesses says a lot. Most importantly, it says that China is serious about its crackdown on property development.
That has big implications for Australia’s iron ore exports and its miners.
The ‘big three’ — BHP, Rio, and Fortescue — all rallied this week on the back of hopes of China relaxing its hard stance on property development. Be warned, it’s a bear market rally.
The chart below shows how the Aussie resource sector (driven by the big iron ore miners) broke from the broader index in August for the first time since the commodity bull market got underway in early 2016.
That tells you something doesn’t it? It tells you that for the first time in years, China is serious about slowing down its runaway property construction train. This will deal a pretty big demand-side blow to the iron ore price, and will continue to do so into the future.
And as I’ve pointed out previously, this is all happening at a time of increased supply coming from Brazilian iron ore giant Vale.
Here’s another chart that illustrates just how serious China is about containing its property sector. It shows the iron ore price (green) and the yuan/US dollar exchange rate (black).
As you can see, usually the exchange rate tracks the iron ore price. But ever since iron ore collapsed in August, this relationship has broken down. The yuan is stubbornly strong.
A strong yuan (even in the face of a rising US dollar) tells you that monetary policy is on the tight side in China. China’s official interest rate is 3.85%. Along with a very strong trade surplus, this is attracting large capital inflows and keeping the yuan elevated.
Tight monetary policy is what China needs to stop the property speculation. But it risks slowing down the broader economy in the process.
China is walking a tightrope. It remains one of the biggest risks to the world economy as we head into 2022…
Editor, The Rum Rebellion
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